China’s property giants are notorious for their rapacious issuance of debt. But a more politically sensitive liability has risen even faster, posing a less well known risk to the country’s housing market. Unearned revenue—the line on developers’ balance sheets that accounts for presales or contracted sales—now makes up a greater share of the 10 largest property developers’ liabilities than total debt. Their combined unearned revenue rose to just over $400 billion in June, according to financial results covering the first half of 2019.
The practice of selling homes once construction has started—but often years before completion—now makes up more than 85% of total sales in China.
Yields of above 10% aren’t uncommon on Chinese property bonds, making presales an attractive source of financing. Companies don’t need to pay interest or promise a specific date of completion. China has no escrow system and developers have access to the full payment. But the game can’t run on forever. At some point, properties promised must be built. Until around the beginning of 2016, completions of residential housing had a relatively close relationship with presales, according to National Bureau of Statistics data. That made sense: Today’s pre-sale is tomorrow’s completed house, so the two should be closely aligned.
But the two have since diverged in an extreme way. Completions are now well below their 2014 peak, while presales have continued to surge. In the 12 months to August, the NBS recorded more than twice as much floor space presold as completed, a gap of more than 600 million square meters. One reason for the divergence is likely developers selling down excess inventories. These fell dramatically between 2015 to 2018, having roughly doubled during the previous credit binge. Getting cash upfront rather than raising debt to build houses they haven’t sold—and may never sell—means companies are no longer creating ghost cities of unoccupied apartments, protecting home prices. But it still leaves developers vulnerable to a downturn in demand—or, more likely, a regulatory clampdown. They would have to complete a year’s worth of construction just to cover the backlog created over the past year, let alone previous commitments. Public complaints have begun appearing in local Chinese media, and this is only likely to ramp up. One woman in Hebei province reportedly bought a 22nd-story apartment in 2015, only to discover recently that the building had been topped out at the 18th floor. Last summer, China’s peer-to-peer lenders discovered that even minor public discontent can prompt a rapid crackdown on unscrupulous financial activity. As in many countries, housing plays a totemic role in the Chinese people’s understanding of financial security. If the government fears that social compact is under threat, political pressure on developers to fulfill their promises will be immense. When that day comes, property developers may wish they had chosen to borrow from the vigilantes in the bond market rather than China’s middle class. Write to Mike Bird at Mike.Bird@wsj.com
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